Introduction to Managerial Accounting
Definition

Managerial accounting is a financial information system designed to assist in the management of an enterprise.
Ethics

The Institute for Management Accountants represents managerial accountants and calls on them to abide by a strict code of ethics. No financial information system provides value unless it is produced with integrity. We tend to blow off the ethics section in our books. The Enron debacle reminds us of our lack of wisdom in doing so.
Cash flow versus income flow

Having cash available for pay one’s bills is clearly important and tracking the flow of receipts and payments through an enterprise is equally important. A direct cash flow statement makes the tracking of operational cash much easier than an indirect cash flow statement. Companies tend to provide the latter. Many suspect it is because it is less revealing and more confusing than the former!

Neither form of cash flow, though, provides the answer to the managerial accountant’s basic question: How efficiently is the firm managed? A farmer may pay in one period for seed corn and sell the harvest in the next period. One period reveals cash out; the other cash in. The really important information is whether the cash in exceeds the cash out. In other words, one needs an income statement in which one matches revenues (increases in retained earnings) with expenses (decreases in retained earnings) to see whether there is positive net income – and, if so, how much.

Income statements originated with retail businesses and follow a standard format. Revenue less cost of goods sold (really expense of goods sold) less selling expenses, less administrative expenses, less financing expenses i.e., interest, less tax expense. The cost of goods sold is essentially the wholesale cost of the item while revenue is its retail value.

Manufacturing businesses follow the same pattern as retail businesses except that they have to figure out what that cost of goods sold is. Following the pattern of retail businesses, cost of goods sold is all costs that are not selling, administrative, financing, or tax related. Turning that around, cost of goods sold includes all costs associated with the production or manufacture of the product. These costs are known generically as product costs while the non-product costs are known as period costs.

Service businesses have no “product” as such and typically show no cost of goods sold – merely period costs – or more accurately period expenses.
Product costs and Inventory
To facilitate the matching of product costs with revenue i.e., to enable one to compute a gross margin, all product-related costs are stored in an inventory account until such time as the inventory is sold. At that point, inventory is reduced and the amount of its reduction is charged to cost of goods sold i.e., reduces retained earnings.

In the case of manufacturing companies, materials used in production, wages of factory workers, wages of supervisors, rent of factory buildings, depreciation of factory machines are all charged to inventory. Wage expense, therefore, is only non-production wages; depreciation expense is only non-production depreciation e.g., depreciation of office buildings. All manufacturing costs are captured in inventory and expensed at the time of sale in the form of one aggregate number called cost of goods sold.
Period costs
All non-product costs i.e., period costs are expensed in the period incurred. Advertising, for instance, is expensed in the period in which the advertisement runs – not the period in which it is paid for. Wage expense represents the cost of the effort of non-manufacturing employees in the period in which they supplied that effort – not the period in which they are paid for that effort.
Assets and their costs
Another way to approach this issue of product and period costs is through the balance sheet. We note first that assets, specifically accounting assets meaning those assets that accountants recognize, are defined by three characteristics. They are economic resources, under the control of the entity (sometimes a slippery concept), and the result of a transaction. They are measured by all necessary costs to bring them to state and place for intended use.

Equipment costs include purchase price, installation costs, testing costs – and even training costs. Capitalization of costs ends when the equipment is ready for its intended use. If the asset is subsequently significantly enhanced i.e., its intended use is altered, the enhancement costs may be capitalized.

Inventory costs are computed similarly. All necessary costs to bring inventory to the state and place for its intended use are part of its book value. In short, all product costs, but no period costs, are included in the cost of manufacturing inventory. The result is what is termed the full cost of inventory.

Questions:

1.What effect does the depreciation of office equipment have on retained earnings? Manufacturing equipment?
2.What effect does the servicing of office equipment have on retained earnings? Manufacturing equipment?
3.What effect would the addition of a high-speed motor to a piece of office equipment have on retained earnings? Manufacturing equipment?